Investors drive the fundraising process

Limited partners will boost their commitments this year, but on their own terms

By

Tom Fairless

May 10, 2010 Updated: 2:31 p.m. GMT

Last year, the private equity industry experienced the biggest storm of what had, admittedly, been a short life. Amid frozen debt markets and uncertainty about economic growth, most firms battened down the hatches and focused on helping portfolio companies weather the crisis.

As dealflow dried up, limited partners - the investors in private equity funds - slowed their commitments to the industry to a trickle.

As the storm abates, however, investors have not lost their enthusiasm for the asset class, judging by the results of the inaugural survey of investors carried out by Private Equity News, Financial News's sister publication. Despite the trauma of last year, more than half of respondents expected to increase the pace of commitments this year, with only 10% planning to pull back.

Part of the reason for the resurgence is that appetite is rebounding from a very low base. Jos van Gisbergen, senior fund manager at Netherlands-based investor Mn Services, said: "Most LPs will invest more in private equity in 2010 because investment last year was so low."

Investors also remain convinced of the benefits of private equity, according to Jeremy Coller, founder of secondaries specialist Coller Capital. He said: "More broadly, LP appetite has held up, because - even if a few investors have been discouraged by changed circumstances or unrealistic expectations - most still think private equity has a good risk-return profile relative to, and in combination with, other asset classes."

That does not mean a return to the boom years for private equity firms. Sensing that the pendulum of power has swung their way, investors are adamant that, this time, they will invest on their terms. That means a determined push for lower fees and greater transparency.

Mark Wignall, chief executive of UK mid-market firm Matrix Private Equity Partners, said: "Greater savviness from LPs is the vein that runs through this survey. Investors are pushing for greater control over their investments, more transparency and lower fees. While they may be willing to invest more in private equity, they want to make some adjustments."

Evidence has emerged in recent weeks that investors are getting their way. US buyout firm Apollo Global Management said last month it would trim the fees it charged Calpers, the biggest US pension fund, by $125m (?98m) over the next five years. Other firms, including First Reserve Corporation, are said to be renegotiating terms with Calpers, while TPG and Carlyle have made concessions, according to reports.

David Currie, chief executive of fund of funds SL Capital Partners, said: "Investors currently have the upper hand in negotiations with private equity firms, and are pressing for lower fees and potentially lower carried interest. Some of the big US pension funds are flexing their muscles over fees. But how long they will retain the balance of power is uncertain."

Some firms will face more pressure than others to cut fees, according to Ross Marshall, chief executive of UK mid-market firm Dunedin. He said: "Mega-funds, in particular, are under pressure to reduce fees, because their earnings from fees have been so high. But top firms will still be able to charge more if they have outperformed."

Investors' new-found power has also encouraged them to invest in new ways. Nearly three quarters of respondents said they expected to increase co-investment or start a co-investment programme this year. This strategy enables limited partners to invest more in specific transactions, thereby boosting exposure to the best deals and locking in favourable terms.

According to van Gisbergen, co-investment provides a way for investors to curb high fees. He said: "Funds of funds seem already to be favouring co-investment, but there is still a long and bitter debate among other institutional investors. They are not yet co-investing because there is no one to underwrite the deals."

Nearly a fifth of investors plan to start or increase direct dealmaking, which involves bypassing private equity firms and buying stakes in companies directly. Several large Canadian pension funds have pushed into direct investment in recent weeks.

Last month, the Ontario Teachers' Pension Plan won the auction to acquire Camelot Group, the UK National Lottery operator, for about £389m (?459m), beating buyout firm CVC Capital Partners.

The Alberta Investment Management Corporation, another Canadian pension fund, expressed an interest in acquiring listed UK buyout house Candover Investments, according to a source close to the matter.

Inevitably, investors' new assertiveness will create losers. Those firms that have underperformed will find themselves unable to raise new funds. More than 80% of respondents to the poll said they would invest with new firms to help boost returns, with three-quarters expecting a subsequent consolidation among general partners, or private equity firms.

According to Marshall, about 20% of firms might disappear "in the next few years", although new firms are likely to spring up in their place.

Wignall said: "The industry's customer base senses that greater consolidation is likely, but that will probably not happen in the coming year. Over the next three years, though, we will start to see significant consolidation."